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Is Wall Street Now Immune to D.C. Dysfunction?

Michael Santoli

•August 12, 2013

This bull market has trampled its share of time-cured, parchment-writ Wall Street rules of thumb since it began running nearly four and a half years ago.

Reuters

The third year of a president’s term has historically been the strongest, on average of the four-year electoral cycle. Yet 2011 was by far the weakest of the Obama years, with the Standard & Poor’s 500 index finishing flat while featuring a 19% mid-summer collapse. The first half of a new presidential term tends to be weak, yet this year the market shot higher from the start and was up more than 13% through June 30.

And, of course, the excessively discussed “Sell in May” adage – based on the fact that stocks over time have done much better from October to May than in the other half of the year – has so far been bucked, with the indexes besting the springtime highs this summer.

The Congressional climb

A lesser known, but quite pronounced, market tendency has also been resoundingly defied this year. The vast majority of stocks’ aggregate gains since 1965 occurred when Congress was in recess. Yet, year to date, almost all the S&P 500’s 16% climb came while Congress was in session.

Through Monday morning, with the S&P 500 at 1,690, the index had gained some 263 points since Dec. 31, and more than 216 of them – or 82% of the net rise – occurred when the House of Representatives and/or Senate were open for the "people’s business."

This is quite a turnabout from recent decades. From 1965 through last year, the market returned an annualized 16.55% on days when Congress was in recess, versus less than 1% annualized on days when the legislature was in session. These figures are courtesy of the Congressional Effect Fund (CEFFX). This is a small, gimmicky-seeming mutual fund whose very existence says much about how Americans’ cynicism regarding their representatives is viewed by some as a tidy marketing opportunity.

The fund invests in the S&P 500 on days when Congress is out, then goes to cash when it reopens. This approach has left the fund sidelined during most of the 2013 rally, knocking its year-to-date return down to 3.9%. In the three years through June 30, the fund returned 2.09% versus 18.27% for the broad market, while taking on about half the market risk as the S&P 500.

Explaining why this shift has occurred is impossible, but attempts should probably begin with the decent possibility that the Congressional effect as chronicled for decades was at least partly a matter of coincidence or statistical noise. Of course, plenty will suggest the Federal Reserve’s ongoing aggressive monetary stimulus – being applied to an economy that has performed better than many forecasters feared this year – is overcoming other headwinds in lifting stocks.

Or, perhaps, stock prices are belatedly responding to three years of improving corporate results now that many of the large-scale meltdown threats have receded.

Washington-driven anxiety ahead

This upending – at least for the moment – of a longstanding stop-go signal for investors is especially worth noting right now, given that Wall Street chatter is now focusing more on the prospect of Washington-driven anxiety building in the weeks ahead.

Congress left for its August break at the close of business Aug. 2 – which so far marks the absolute market high for the year – and returns Sept. 9. Last week stocks saw their biggest weekly decline since June of this year.

Having done very little for most of this year as the automatic “sequester” federal spending cuts took hold, lawmakers will return in September ready to fight over a 2014 budget, debate another needed increase on the federal debt ceiling and most likely hold confirmation hearings for the next chairman of the Federal Reserve.

So maybe another campaign of politically motivated Washington trench warfare is indeed approaching. Has the market proven this year that it’s immune to the feckless, crisis-stoking battles of a polarized legislature?

It’s probably far too cute to bet heavily that this is the case, especially if – as suggested here – investors have pivoted from overestimating the damage that D.C. might inflict to perhaps shrugging off the threat of politics on the market a bit too blithely amid the 2013 rally.